is, however, usually overestimated. So much depends, especially in
America, upon the size of the crops, the temper of the people, and the
policies adopted by leading politicians, that the future of business
becomes a very complicated problem. No power can drive the American
people. Any control over their action has to be exercised by cajolery
or by devious and circuitous methods.
Moreover, public opinion is becoming more volatile and changeable
year by year, owing to the quicker spread of information and the rapid
multiplication of the reading public. One can easily imagine that some
of our older financiers must be saying to themselves, “If I had only
had my present capital in 1870, or else had the conditions of 1870 to
work on today!”
A fair idea of when the discounting process will be completed may
usually be formed by studying conditions from every angle. The great
question is, when will the buying or selling become most general and
urgent? In 1907, for example, the safest and best time to buy the sound
dividend-paying stocks was on the Monday following the bank statement
which showed the greatest decrease in reserves. The markets opened down
several points under pressure of liquidation, and standard issues never
sold so low afterward. The simple explanation was that conditions had
become so bad that they could not get any worse without utter ruin,
which all parties must and did unite to prevent.
Likewise in the Presidential campaign of 1900, the lowest prices
were made on Bryan’s nomination. Everyone said at once, “He can’t be
elected.” Therefore his nomination was the worst that could happen—the
point of time where the political news became most intensely bearish.
As the campaign developed his defeat became more and more certain, and
prices continued to rise in accordance with the general economic and
financial conditions of the period.
It is not the discounting of an event thus known in advance to
capitalists, that presents the greatest difficulties, but cases where
considerable uncertainty exists, so that even the clearest mind and
the most accurate information can result only in a balancing of
probabilities, with the scale perhaps inclined to a greater or less
degree in one direction or the other.
In some cases the uncertainty which precedes such an event is more
depressing than the worst that can happen afterward. An example is a
Supreme Court decision upon a previously undetermined public policy
which has kept business men so much in the dark that they feared to
go ahead with any important plans. This was the case at the time of
the Northern Securities decision in 1904. “Big business” could easily
enough adjust itself to either result. It was the uncertainty that was
bearish. Hence the decision was practically discounted in advance, no
matter what it might prove to be.
This was not true to the same extent of the Standard Oil and American
Tobacco decisions of 1911, because those decisions were an earnest of
more trouble to come. The decisions were greeted by a temporary spurt
of activity, based on the theory that the removal of uncertainty was
the important thing; but a sensational decline started soon after
and was not checked until the announcement that the Government would
prosecute the United States Steel Corporation. This was deemed the
worst that could happen for some time to come, and was followed by a
considerable advance.
More commonly, when an event is uncertain the market estimates the
chances with considerable nicety. Each trader backs his own opinion,
strongly if he feels confident, moderately if he still has a few
doubts which he cannot down. The result of these opposing views may
be stationary prices, or a market fluctuating nervously within a
narrow range, or a movement in either direction, greater or smaller in
proportion to the more or less emphatic preponderance of the buying or
selling.
Of course it must always be remembered that it is the dollars that
count, not the number of buyers or sellers. A few great capitalists
having advance information which they regard as accurate, may more than
counterbalance thousands of small traders who hold an opposite opinion.
In fact, this is a condition very frequently seen, as explained in a
previous chapter.
Even the operations of an individual investor usually have an effect
on prices pretty accurately adjusted to his opinions. When he believes
prices are low and everything favors an upward movement, he will strain
his resources in order to accumulate as heavy a load of securities as
he can carry. After a fair advance, if he sees the development of some
factor which _might_ cause a decline—though he doesn’t really believe
it will—he thinks it wise to lighten his load somewhat and make sure of
some of his accumulated profits. Later when he feels that prices are
“high enough,” he is a liberal seller; and if some danger appears while
the level of quoted values continues high, he “cleans house,” to be
ready for whatever may come. Then if what he considers an unwarranted
speculation carries prices still higher, he is very likely to sell a
few hundred shares short by way of occupying his capital and his mind.
It is, however, the variation of opinion among different men that has
the largest influence in making the market responsive to changing
conditions. A development which causes one trader to lighten his line
of stocks may be regarded as harmless or even beneficial by another,
so that he maintains his position or perhaps buys more. Out of a
world-wide mixture of varying ideas, personalities and information
emerges the average level of prices—the true index number of investment
conditions.
The necessary result of the above line of reasoning is that not only
probabilities but even rather remote possibilities are reflected in the
market. Hardly any event can happen of sufficient importance to attract
general attention which some process of reasoning cannot construe as
bullish and some other process interpret as bearish. Doubtless even
our old friend of the news columns to the effect that “the necessary
activities of a nation of ninety million souls create and maintain a
large volume of business,” may influence some red-blooded optimist
to buy 100 Union; but the grouchy pessimist who has eaten too many
doughnuts for breakfast will accept the statement as an evidence of
the scarcity of real bull news and will likely enough sell 100 Union
short on the strength of it.
It is the overextended speculator who causes most of the fluctuations
that look absurd to the sober observer. It does not take much to make
a man buy when he is short of stocks “up to his neck.” A bit of news
which he would regard as insignificant at any other time will then
assume an exaggerated importance in his eyes. His fears increase in
geometrical proportion to the size of his line of stocks. Likewise the
overloaded bull may begin to “throw his stocks” on some absurd story of
a war between Honduras and Roumania, without even stopping to look up
the geographical location of the countries involved.
Fluctuations based on absurdities are always relatively small. They
are due to an exaggerated fear of what “the other fellow” may do.
Personally, you do not fear a war between Honduras and Roumania; but
may not the rumor be seized upon by the bears as an excuse for a raid?
And you have too many stocks to be comfortable if such a break should
occur. Moreover, even if the bears do not raid the market, will there
not be a considerable number of persons who, like yourself, will fear
such a raid, and will therefore lighten their load of stocks, thus
causing some decline?
The professional trader, following this line of reasoning to the limit,
eventually comes to base all his operations for short turns in the
market not on the facts but on what he believes the facts will cause
others to do—or more accurately, perhaps, on what he _sees_ that the
news _is_ causing others to do; for such a trader is likely to keep his
finger constantly on the pulse of buying and selling as it throbs on
the floor of the Exchange or as recorded on the tape.
The non-professional, however, will do well not to let his mind stray
too far into the unknown territory of what others may do. Like the
“They” theory of values, it is dangerous ground in that it leads
toward the abdication of common sense; and after all, others may not
prove to be such fools as we think they are. While the market is likely
to discount even a possibility, the chances are very much against _our_
being able to discount the possibility profitably.
In this matter of discounting, as in connection with most other stock
market phenomena, the most useful hint that can be given is to avoid
all efforts to reduce the movement of prices to rules, measures, or
similarities and to analyze each case by itself. Historical parallels
are likely to be misleading. Every situation is new, though usually
composed of familiar elements. Each element must be weighed by itself
and the probable result of the combination estimated. In most cases
the problem is by no means impossible, but the student must learn to
look into the future and to consider the present only as a guide to
the future. Extreme prices will come at the time when the news is most
emphatic and most widely disseminated. When that point is passed the
question must always be, “What next?”
V—Confusing the Personal with the General
In a previous chapter the fact has been mentioned that one of the
greatest difficulties encountered by the active trader is that of
keeping his mind in a balanced and unprejudiced condition when he is
heavily committed to either the long or short side of the market.
Unconsciously to himself, he permits his judgment to be swayed by his
hopes.
A former large speculator on the Chicago Board of Trade, after being
short of the market and very bearish on wheat for a long time, one
day surprised all his friends by covering everything, going long a
moderate amount, and arguing violently on the bull side. For two days
he maintained this position, but the market failed to go up. He then
turned back to the short side, and had even more bear arguments at his
tongue’s end than before.
To a certain extent he did this to test the market, but still more to
test himself—to see whether, by changing front and taking the other
side, he could persuade himself out of his bearish opinions. When even
this failed to make any real change in his views, he was reassured and
was ready for a new and more aggressive campaign on the short side.
There is nothing peculiar about this condition. While it is especially
difficult to maintain a balanced mind in regard to commitments in the
markets, it is not easy to do so about anything that closely touches
our personal interests. As a rule we can find plenty of reasons for
doing what we very much want to do, and we are still more prolific with
excuses for not doing what we don’t want to do. Most of us change the
old sophism “Whatever is, is right” to the more directly useful form
“Whatever I want is right.” To many readers will occur at once the
name of a man prominent in public life who seems very frequently to act
on this motto.
If Smith and Jones have a verbal agreement, which afterwards turns
out to be greatly to Jones’ advantage, Smith’s recollection is that
it was merely a loose understanding which could be cancelled at any
time, while Jones remembers it to have been a definite legal contract,
perfectly enforceable if it had only been written. Talleyrand said that
language was given us for the purpose of concealing thought. Likewise
many seem to think that logic was given us for the purpose of backing
up our desires.
Few persons are so introspective as to be able to tell where this bias
in favor of their own interests begins and where it leaves off. Still
fewer bother to make the effort to tell. To a great extent we train our
judgment to lend itself to our selfish interests. The question with us
is not so much whether we have the facts of a situation correctly in
mind, as whether we can “put it over.”
When it comes to buying and selling stocks, there is no such thing as
“putting it over.” The market is relentless. It cannot be budged by our
sophistries. It will respond exactly to the forces and personalities
which are working upon it, with no more regard for our opinions than
if we couldn’t vote. We cannot work for our own interests as in other
lines of business—we can only fit our interests to the facts.
To make the greatest success it is necessary for the trader to forget
entirely his own position _in_ the market, his profits or losses, the
relation of present prices to the point where he bought or sold, and to
fix his thoughts upon the position _of_ the market. If the market is
going down the trader must sell, no matter whether he has a profit or a
loss, whether he bought a year ago or two minutes ago.
How far the average trader is from attaining this point of view is
quickly seen from his conversation, and it is also true that a great
deal of the literature of speculation absolutely fails to reach this
conception.
“You have five points profit—you had better take it,” advises the
broker. Perhaps so, if you know nothing about the market; but if you
understand the market the time to take your profit is when the upward
movement shows signs of culminating, regardless of your own deal.
“Stop your losses; let your profits run” is a saying which appeals to
the novice as the essence of wisdom. But the whole question is _where_
to stop the losses and _how far_ to let the profits run. In other
words, what is the _market_ going to do? If you can tell this your
personal losses and profits will take care of themselves.
Here is a man who has done a great deal of figuring and has proved to
his own satisfaction that seven points is the correct profit to take
in Union Pacific, while losses should be limited to two and one-half
points. Nothing could be more foolish than these arbitrary figures. He
is trying to make the market fit itself around his own trades, instead
of adapting his trades to the market.
In any broker’s office you will notice that a large part of the talk
concerns the profits and losses of the traders. Brown had a profit of
ten points and then let it get away from him. “Great Scott!” says his
wise friend. “What do you want? Aren’t you satisfied with ten points
profit?” The reply should be, though it rarely is, “Certainly not, if I
think the market is going higher.”
“Get them out with a small profit,” I once heard one broker say to
another. “If you don’t they will hang on and take a loss. They never
get profit enough to satisfy them.” A good policy, probably, if neither
the broker nor his customer had any real knowledge of the market; but
mere nonsense for the trader who aims to be in the slightest degree
scientific.
The fact is that the more a trader allows his mind to dwell upon his
own position in the market the more likely it is that his judgment
will become warped so that his mind is blind to those considerations
which do not fall in with his preconceived opinion.
Until you try it, you have almost no idea of the extent to which you
may be rendered unreasonable by the mere fact that you are committed
to one side of the market. “In the market, to be consistent is to be
stubborn,” some one has said; and it is true that the man of strong
will and logical intellect is often less successful than the more
shallow and volatile observer, who is ready to whiffle about like the
weathercock at any suspicion of a change in the wind. This is because
the strong man has in this instance embarked upon an enterprise where
he cannot use his natural force and determination—he can employ only
his faculties of observation and interpretation. Yet in the end the
man of character will be the more permanently successful, because he
will eventually master his subject more thoroughly and attain a more
judicial attitude.
The more simple-minded, after once committing themselves to a position,
are thereafter chiefly influenced and supported by the illusions of
hope. They bought, probably, as a result of some bullish development.
If prices have advanced, they find that the market “looks strong,” a
good deal of encouraging news comes out on the tickers, and they hope
for large profits. After five points in their favor, they hope for ten,
and after ten they look for fifteen or twenty.
On the other hand, if prices decline they charge it to “manipulation,”
“bear raids,” etc., and expect an early recovery. Much of the bear news
appears to them to be put out maliciously, in order to cause prices to
decline further. It is not until the decline begins to cause a painful
encroachment upon their capital that they reach the point of saying,
“If ‘they’ can depress prices like this in the face of a bullish
situation, what is the use of fighting them? By a flood of short
sales, they can put prices down as much as they like”—or something of
the sort.
Such traders are suffering merely from youth, or lack of sound business
sense, or both. They have a considerable period of study before them,
if they persist until they get permanently profitable results. Most of
them, of course, do not persist.
A much more intelligent class, many of whom are properly to be
considered as investors, do not allow their position in the market
to blind them so far as current news or statistical developments are
concerned, but do permit themselves to become biased in regard to the
most important factor of all—the effect of a change in the price level.
They bought stocks in the expectation of an improved situation. The
improved situation comes and prices rise. Nothing serious in the way
of bear news appears. On the contrary, bull news continues plentiful.
Under these conditions they see no reason for selling.
Yet there may be a most important reason for selling—namely, that
prices have risen sufficiently to counterbalance the improved
situation—and they would see and appreciate this fact if they were in
the position of an uninterested observer.
One of the principal reasons why investors of this class allow
themselves to become confused as to the influence of the price level is
because a bull market nearly always goes unreasonably high before it
culminates. The investor has perhaps, in several previous instances,
sold out at what he thought was a fair price level, only to see the
public run away with the market to a point where his profits would have
been doubled if he had held on.
It is in such cases that an expert knowledge of speculation is
essential. If the investor has not this knowledge, and cannot obtain
the dependable advice of one who has it, then he must content himself
with more moderate profits and forego the expectation of getting the
full benefit of the advance. But with a fair knowledge of speculative
influences, he can fix his mind on the development of the campaign,
regardless of his own holdings, and can usually secure a larger profit
than if he depended merely upon ordinary business “common sense.”
The mistake is made when, without any expert knowledge of speculation,
he permits himself to hold on in the hope of higher prices after a
level has been reached which has fairly discounted improved business
conditions.
Not one trader in a thousand ever becomes so expert or so seasoned as
to entirely overcome the influence his position in the market exerts
upon his judgment. That influence appears in the most insidious and
elusive ways. One of the principal difficulties of the expert is in
preventing his active imagination from causing him to see what he is
looking for just because he is looking for it.
An example will make this clear. The expert has learned from
experience, let us say, that the appearance of “holes” in the market
is a sign of weakness. By a “hole” is meant a condition of the market
where it suddenly and unaccountably refuses to take stock. A few
hundred shares of an active stock are offered for sale. Sentiment is
generally bullish, but there is no buyer for that stock. Prices slip
quickly down half a point or a point before buyers are found. This, in
an active stock, is unusual; and although the price may recover, the
professional does not forget this treacherous failure of the market to
accept moderate offerings. He considers it a sign of an “over-bought”
market.
Now suppose the trader has calculated that an advance is about to
culminate and has taken the short side in anticipation of that event.
He suspects that the market is over-bought, but is not yet sure of it.
Under these circumstances any little dip in the price will perhaps look
to him like a “hole,” even though under other conditions he would
not notice it or would think nothing about it. He is looking for the
development of weakness and there is danger that his imagination may
show him what he is looking for even though it isn’t there!
The same remarks would apply to the detection of accumulation or
distribution. If you want to see distribution after a sharp advance,
you are very likely to see it. If you have sold out and want to get a
reaction on which to repurchase, you will see plenty of indications
of a reaction. Indeed, it is a sort of proverb in Wall Street that
there is no bear so bearish as a sold out bull who wants a chance to
repurchase.
In the study of so-called “technical” conditions of the market,
a situation often appears which permits a double construction.
Indications of various kinds are almost evenly balanced; some things
might be interpreted in two different ways; and a trader not already
interested in the market would be likely to think it wise to stay out
until he could see his way more clearly.
Under such circumstances you will find it an almost invariable rule
that the man who was long before this condition arose will interpret
technical conditions as bullish, while the man who was and remains
short, sees plain indications of technical weakness. Somewhat amusing,
but true.
In this matter of allowing the judgment to be influenced by personal
commitments, very little of a constructive or practically helpful
nature can be written, except the one word “Don’t.” Yet when the
investor or trader has come to realize that he is a prejudiced
observer, he has made progress; for this knowledge keeps him from
trusting too blindly to something which, at the moment, he calls
judgment, but which may turn out to be simply an unusually strong
impulse of greed.
It has often been noted by stock market writers that since the great
public is bearish at the bottom and bullish at the top, it could make
its fortune and beat the multi-millionaires at their own game by
simply reversing itself—buying when it feels like selling and selling
when it feels like buying. Tom Lawson, in the heyday of his publicity,
seems to have had some sort of dream of the public selling back to
Standard Oil capitalists the stocks which it had bought from them and
thus bringing everything to smash in a heap—the philanthropic Thomas,
doubtless, being first properly short of the market.
This wrongheadedness of the public no longer exists to the same
extent as formerly. A great number of small investors buy and sell
intelligently and there has been a most noticeable falling off in the
gambling class of trade—much to the satisfaction of everyone, except,
perhaps, the brokers who formerly handled such business.
It remains true, nevertheless, that the very moment when the market
looks strongest, is likely to be near the top, and just when prices
appear to have started on a straight drop to the zero point is usually
near the bottom. The practical way for the investor to use this
principle is to be ready to sell at the moment when bull sentiment
seems to be most widely distributed, and to buy when the public in
general seem most discouraged. It is especially important for him to
bear this principle in mind in taking profits on previous commitments,
as his own interests are then identified with the current trend of
prices.
In a word, the trader or investor who has studied the subject enough
to be reading this book, probably could not make profits by reversing
himself, even if such a thing were possible; but he can endeavor to
hold himself in a detached, unprejudiced frame of mind, and to study
the psychology of the crowd, especially as it manifests itself in the
movement of prices.
VI—The Panic and the Boom